Isaac Newton loses his fortune

Isaac Newton loses his fortune

8.7.2007

There is an increasing amount of concern about the protracted bull market in world equity markets. Since March 2003, almost every stock market has increased in value (and on average, world markets have almost doubled).

Memories of the “Dotcom Wreck” starting in 2000 are still fresh. The Nasdaq index is a good proxy for this financial disaster:



The graph shows the dramatic growth in share prices that started late in 1998. The hype about the potential of the Net was being pushed daily in all the media. “This time it’s different” was the mantra of the TV commentators.

• If you had invested in 1998 (when the Nasdaq was around 1400), your money would have more than tripled by the time the Nasdaq peaked at over 5000 in March 2000.
• Three years of misery followed where investors (those that hung on) lost 80% of their money (in October 2002 the Nasdaq was at around 1100.) 
• In the following 5 years, the Nasdaq has more than doubled.

South Sea Bubble

Flashback to the early 1700s. England was in a spot of bother having sent itself broke fighting a war involving the French, Spanish and money. The government approached the South Sea Company to help them out, and put conditions in place to attract investors. People always want to make a quick buck, and the investors enthusiastically invested – in droves. From the story in stock market crash.net:

Speculation became rampant as the share price kept skyrocketing. It was thought that this company “could never fail”.

One of the main money-making ventures of the South Sea Company was trading African slaves for the Americans.

Isaac Newton

Even Isaac Newton got caught up in the South Sea mania and invested a big chunk of his fortune. Interestingly, he pulled out early (after making a respectable 7000 pounds) then went back in after the bubble continued to inflate. The inevitable bust happened and he lost 20,000 pounds – a considerable sum at the time.

As a result of this crisis, he stated “I can calculate the motions of heavenly bodies, but not the madness of people”.

Footnote 1: Some of the Dotcom mania was well founded. Google, YouTube, Yahoo and others have gone on to develop highly successful Web-based businesses, worth billions. The problem in the late 1990s was that investors were happy to fund companies with no business plan and no hope of profits. The “madness of people” indeed.

Footnote 2: I don’t wish to imply that investing in stocks is dangerous – quite the opposite. If you don’t invest, you are setting yourself up for later poverty. But what you need to do is be careful to avoid hype and to be able to spot a bubble.

Footnote 3: For another speculative bubble (involving Japanese real estate), see Math of House Buying.

http://www.squarecirclez.com/blog/isaac-newton-loses-his-fortune/688

Check the charts occasionally to sense mob hysteria or panic at work

Some people in the markets use graphs of previous stocks or commodity movements in order to predict future price movements.  They are called "technicians" or "chartists."  They spend a lot of time pouring over the historic price movements and the formations these show on their charts as a way to predict what will happen next.

Ordinarily, I do not use charts to trade.  Occasionally, I will turn to them as a way to see what has been happening and to check facts if I sense mob hysteria or panic at work.  

Charts sometimes reveal a beeline rise, an indication that prices have increased far beyond actual value.  It means that people have lost perspective.  It shows the level of the hysteria.  I know that prices will eventually return to the appropriate level, so I sell short.  You need to be careful, though, that you are not selling short simply because prices are high.  Never sell short unless prices are astronomically expensive, AND you detect negative change coming.  

You can see panic in falling prices when you see them collapsing straight down day after day for extended periods.  Historically, long periods of selling have ended in "selling climaxes" when everyone finally panics and dumps to get out of the market at any price no matter what the fundamental reality might be.  Large price declines across the board should attract your attention. 

A good rule of thumb is to sell during times of market hysteria and buy during times of panic.  Always remember to buy low and sell high.


Ref:
Jim Rogers
A Gift to My Children

Selling Hysteria

For the most part, it is in short-term trades that prices are driven by emotion.  Mid-term and long-term investments are usually influenced more by the fundamentals.

Bubbles burst in the wake of hysteria, while plummeting prices usually end in panic.

You can see panic in falling prices when you see them collapsing straight down day after day for extended periods.  Historically, long periods of selling have ended in "selling climaxes" when everyone finally panics and dumps to get out of the market at any price no matter what the fundamental reality might be.

Large price declines across the board should attract your attention.  A good rule of thumb is to sell during times of market hysteria and buy during times of panic.  

Always remember to buy low and sell high.  It sounds so simple, but it is extremely difficult.  Just keep this dictum in mind always - especially when your emotions are getting the best of you.

Ref:
Jim Rogers
A Gift to My Children

Alan Greenspan on the Financial Collapse

By Morgan Housel 
March 23, 2010 | Comments (81)

Former Federal Reserve Chairman Alan Greenspan just published a 66-page letter on the causes of the financial meltdown and how to avoid a repeat. He presents some great points, and several ridiculous ones as well. Here are a few of each.

Great points
1. Fannie Mae (NYSE: FNM) and Freddie Mac's (NYSE: FRE) role in subprime:

"The firms accounted for an estimated 40% of all subprime mortgage securities … during 2003 and 2004. That was an estimated five times their share of newly purchased and retained in 2002, implying that a significant proportion of the increased demand for subprime mortgage-backed securities during the years 2003-2004 was effectively politically mandated ..."

Wall Street gets vilified for blowing up the financial system. As it should. But a big part of the mortgage mess had nothing to do with Wall Street. It started with commercial banks making shady loans and ended with Fannie and Freddie's political obligation to buy up these loans in bulk. What's scary is there isn't a plan on what to do with these two rascals. Functionally,nothing has changed since they collapsed.

2. On the role of the rating agencies:  

"[A]n inordinately large part of investment management subcontracted to the 'safe harbor' risk designations of the credit rating agencies. No further judgment was required of investment officers who believed they were effectively held harmless by the judgments of government-sanctioned rating organizations."

It's easy to have no sympathy for those who bought collateralized debt obligations only to learn they were filled with packing peanuts. And I don't. But stupidity wasn't these people's shortfall, to their credit. It was relying on the word of the ratings agencies -- Moody's (NYSE:MCO), Standard & Poor's, and Fitch -- that told them everything was fine and well. And as Greenspan points out, ratings agencies are government-sanctioned entities, so competition for good, high-quality analysis gets stifled.

3. On regulating financial markets:

"In dealing with nonbanks that come in all varieties under the label of 'shadow banking,' it is probably best to regulate financial products rather than institutions."

Bingo. Don't simply regulate Goldman Sachs (NYSE: GS). Its bankers will throw up smokescreens all day around regulators trying to decode its balance sheet. Start at the bottom and regulate (or ban) things like credit default swaps. The only way you'll outsmart these guys is to regulate from the bottom up, not the top down.

4. On "too big to fail":

"Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution."

Hear that, JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon? Now quit acting like civilization will be forced back into hunting and gathering if four banks don't control the economy.

5. On crisis forecasting:

"Forecasters as a group will almost certainly miss the onset of the next financial crisis, as they have so often in the past and I presume any newly designated 'systemic regulator' will also."

I'm like my colleague Matt Koppenheffer on this one: The thought of risk-regulation committees and advisory boards makes me nauseated. Most regulators didn't even acknowledge anything was wrong until chaos was everywhere. And once you realize a bank such as Citigroup (NYSE: C) or Bank of America (NYSE: BAC) is in deep water, it's too late. You've got to install firm rules that prevent insanity in the first place, rather than rely on crisis committees or reactionary policies the way we did in 2008.

Ridiculous points
1. On the Fed's role in the housing boom: 

"The global house price bubble was a consequence of lower interest rates, but it was long-term interest rates that galvanized home asset prices, not the overnight rates of central banks, as has become the seeming conventional wisdom. … No one, to my knowledge, employs overnight interest rates -- such as the fed-funds rate -- to determine the capitalization rate of real estate ..."

If you assume everyone uses a 30-year fixed-rate mortgage, he's right. But how about the roughly one-third of borrowers in 2005 who used adjustable-rate mortgages linked to short-term interest rates set by the Fed? These borrowers represent some of the most egregious excesses of the housing boom, and they couldn't have done it without you, Al.

2. On the impracticality of controlling bubbles:

"At some rate, monetary policy can crush any bubble. If not 6 1/2%, try 20%, or 50% for that matter. Any bubble can be crushed, but the state of prosperity will be an inevitable victim."

Let's look at how this has played out in the past. Facing an inflation bubble in the early 1980s, Greenspan's predecessor, Paul Volcker, raised interest rates to 20%. That hurt for a while, but he's now considered an economic hero for doing it. Inflation collapsed, and real growth boomed. He looked past the short run to save the long run. Greenspan, on the other hand, let this bubble burn itself out. The result, in his own words, was "the most virulent global financial crisis ever." But we preserved prosperity in 2006, people, so apparently it was all worth it.

3. On choices: 

"Unless there is a societal choice to abandon dynamic markets and leverage for some form of central planning, I fear that preventing bubbles will in the end turn out to be infeasible. Assuaging their aftermath seems the best we can hope for."

It's a bit dramatic to assume we can pick either crippling bubbles or central planning, but nothing else. You can simultaneously have dynamic free markets and common-sense rules that prevent pizza delivery guys from living like they're on MTV Cribs. We had something close to this from the end of World War II up until the late '90s. And it was awesome. Bubbles are a natural part of human behavior. That's a given. But it's pretty weak to just roll over and accept their wrath as inevitable.

What do you think? How responsible is Greenspan for the financial meltdown, and what should he have done differently?

http://www.fool.com/investing/general/2010/03/23/alan-greenspan-on-the-financial-collapse.aspx?source=ihpdspmra0000001&lidx=1

Your Money

Preparing for the Inevitable Bursting Bubble

By RON LIEBER

Published: February 26, 2010

Financial bubbles are a way of life now. They can upend your industry, send your portfolio into spasms and leave you with whiplash. And then, once you’ve recovered, the next one will hit.

 
How are you preparing for the next bubble?

Or so you might think, as a veteran of two gut-wrenching market declines and a housing bubble over the last decade. 


There’s plenty of reason to expect more surprises, given the number of hedge funds moving large amounts of money quickly around the world and the big banks making their own trades. 


Individuals, as always, may be tempted to make their own financial bets, too. Last time, they bought overpriced homes with too much borrowed money. Next time, who knows what the bubble will be? And that’s the problem, as it always is. How do you identify the next thing that will pop? Is it China? Or Greece? Or Treasury bonds? It is difficult to predict and make the right defensive (or offensive) moves at the correct moment to save or make money.


Still, if you want to better insulate yourself from bubbles — however often they may inflate — there are plenty of things you can do. Your debt levels matter, and you may want to consider a more flexible investment strategy. But perhaps most important, this is a mental exercise that begins and ends with an honest assessment of your long-term goals and how you handle the emotional jolts that come from the bubbles that burst along the way.


FIXED EXPENSES
Start with the basics. The less you have to pay toward monthly obligations, the better off you are, and that’s especially true at a time of economic disruption. You certainly wouldn’t want any bills increasing, so now’s a good time to refinance to a fixed-rate mortgage.


Whittle down student loan and credit card debt, too, and pay cash for your car if possible. “Flexibility is priceless in a time of panic,” said Lucas Hail, a financial planner with Foster & Motley in Cincinnati.


SELF-RELIANCE 
Then take a hard look at how much you should rely on promises from the government. Social Security and Medicare may not fit the traditional definition of bubbles, but that hasn’t stopped Rick Brooks from advising his financial planning clients to expect less from both programs. “Something that is not sustainable will not continue. It just can’t,” he said of Medicare.


Mr. Brooks, the vice president for investment management with Blankinship & Foster in Solana Beach, Calif., said anyone under 50 should assume that Medicare will look nothing like it does now and examine private health insurance premiums for guidance as to what may need to be spent on health care in retirement. Meanwhile, the firm advises current retirees to assume a 20 percent cut in Social Security benefits at some point.


Bedda D’Angelo, president of Fiduciary Solutions in Durham, N.C., has an equally stark outlook on long-term employment risk. If there are two adults in the household, your goal should probably be to have two incomes instead of one. “I do believe that unemployment is inevitable,” she said, adding that people who think they are going to retire at 65 should save for retirement as if they will be forced out of the work force in their mid-50s.


PORTFOLIO TACTICS
Perhaps you did what you thought you were supposed to during the last decade. You got religion and stopped trading stocks. Then, you split your assets among various low-cost mutual funds and added money regularly. And the results weren’t quite what you hoped.


Tempted to make big bets on emerging markets or short Treasury bills? You’ve landed in the middle of the debate between those who favor a more passive asset allocation and those who prefer something called tactical allocation.
The first camp sets up a practical mix of investments, according to a target level of risk, and then readjusts back to that mix every year or so.

• They frown on the hubris of the tactical practitioners. To make a tactical approach work, they note, you need to know what the right signals will be to buy and sell everything from stocks to gold, during every future market cycle. Then, these tacticians need to have the discipline to act each and every time. This is extraordinarily hard.

The tacticians, however, believe they have no choice. 

• “What consumers need to know is that no matter how comforting it is to believe a formulaic approach or prepackaged investment product will allow them to put their financial future on autopilot, our current and future financial environment will require advice, diligence, education and responsiveness, which takes into account strategic consideration of geopolitical and economic relationships,” as Ryan Darwish, a financial planner in Eugene, Ore., put it to me this week.

Mr. Darwish scoffed at the notion of mere bubbles and said he thought that more fundamental and far-reaching shifts were under way, like the transfer of economic power from the United States to China and other nations.

A growing number of financial planners are embracing a middle, more measured approach: If diversification across stocks, bonds and other asset classes has proved to be a good thing in most investing environments, why not diversification around investment approaches?

“I am not a financial genius, but the geniuses are even worse off because they’re anchored on one philosophy,” said David O’Brien, a financial planner in Midlothian, Va. So he and a growing number of his peers have added some strategies to their baseline portfolios aimed at losing less during bubbles while still gaining in better times. “We’re not trying to shoot for the moon,” he added.

These tactics can include managed futures, absolute return funds, merger arbitrage and other approaches that will get their own column someday.

The embrace of all this even led one investment professional I spoke with this week to express the ultimate sacrilege: It really is different this time.

Thomas C. Meyer of Meyer Capital Group in Marlton, N.J., noted that many of these alternative strategies were not even available in mutual-fund form three to four years ago. So that’s different. He’s now putting 30 percent of his clients’ equity portfolios into such investments.

The big change, however, is that the baby boomer money is getting older. People are further along in their careers than they were during the market crash in 1987, and they can’t rely on pensions as so many more near retirees could in the 1980s (while shrugging off stock market volatility). And the boomers don’t have as much time to make up lost ground, especially if they’re already retired.

“Losing less means a lot right now,” Mr. Meyer said. “So we want to suck volatility out where we can.”

MATTER OF THE MIND  
But can you live with less volatility — and the permanent end of occasional portfoliowide returns in the teens or higher? Markets run on greed and fear; bubbles expand and deflate thanks to outsize versions of each. One of the few things you can predict about bubbles is that they will test your conviction on where you sit along the fear-greed continuum. 

And once they pop, you’ll know a bit more about how your mind works than you did before.

This last downturn was severe enough that about 10 percent of Steven A. Weydert’s clients realized that they had overestimated their own risk tolerance. “Ideally, with an asset allocation, you never want to look back and say you’re sorry,” said Mr. Weydert of Bowyer, Weydert Wealth Planning Partners in Park Ridge, Ill.

So rather than trying to predict the number and type of bubbles, it may make more sense to look inward when trying to predict the future. Bob Goldman, a financial planner in Sausalito, Calif., said that clients often looked at him blankly when he asked them what it was they imagined for themselves in the future. Sometimes, they need to go home and figure out what sort of life it is that they’re saving for — and how much (or little) it might cost.

“People come in and talk about how we all know that inflation is going to explode next year,” Mr. Goldman said. “Well, we don’t all know that. We don’t know anything. But we can know something about our own lives, and there is a person we can talk to about that. A person in the mirror.”

• STRATEGIES; What The Past Can't Tell Investors (January 3, 2010)

Stock markets flirt with full bubble territory

Stock markets flirt with full bubble territory
With the FTSE 100 back at levels last seen before the collapse of Lehman Brothers, Martin Hutchinson asks whether there is a bubble brewing in asset prices.

Published: 11:36AM GMT 29 Dec 2009

Rapid increases in the prices of financial assets can be a healthy sign. Markets are doing their job when prices jump because of sudden economic strength or a disruption of supply. But when the causes are more monetary than real, a market bubble is forming. Are markets healthy or unhealthy now?

Observers from the Bank of International Settlements to the Hong Kong central bank are asking the question. And quite right, too. The MSCI World stock price index is up 70pc since March and many commodity prices are rocketing. The Reuters-CRB Metals Index is up 74pc over the past year.

Some portion of those increases is probably healthy. Prices were lowest when the financial and economic worlds were undergoing a near-death experience. Banking systems and the economy are not exactly up and running, but the trends are more positive.

Still, some markets seem to have moved past recovery into excess. The jump in commodities, probably the most "financialised" markets in the world, comes despite ample current inventories and limited recovery in demand.

Global stock markets are in danger of hitting full bubble territory. Analysts expect global market earnings to increase by 30pc in 2010, and investors are already paying a fairly generous 14 times those expected earnings, according to Societe Generale calculations.

The case for a bubble is supported by day-to-day market behaviour -- prices often fall on good economic news. Investors seem to care less about the prospect of stronger demand than about the possibility that the authorities will tighten up financial conditions.

If past practice is any guide, the tightening will be slow in coming. Central bankers have not yet fully cast off their long-established belief that asset prices aren't relevant to their task of keeping inflation at bay, while governments find it hard to abandon the many pleasures of deficit spending.

Recent experience should teach another lesson. Financial excess leads to destabilising market crashes. More distant history suggests that monetary excess frequently leads to retail price inflation. Tighter money might make the recovery less robust over the next year or two, but would make the world safer for the next decade.

http://www.telegraph.co.uk/finance/markets/6905092/Stock-markets-flirt-with-full-bubble-territory.html

Stock market crash is triggered by drastic change in sentiment of market players

A stock market boom can be described as a bubble if there is high probability of a large scale fall in share prices.

 

Stock market crash is not triggered

• by fundamental news or
• by a certain level of share overvaluation.

Instead, it happens because of

• a drastic change in the behavior of market players.

 

This is why the necessary and sufficient conditions for the bursting of a given asset price bubble, applicable in practice, cannot be provided with the tools of mathematical economics.

 

A market crash will ensue with a high likelihood if noise trading becomes dominant, the signals of which are to be found in the following stochastic factors:

 

• Increasing effect of leverage.

 

• Increasing activity on part of the economic policy.

 

• Increasing number of corporate scandals, fraud and corruption.

 

• Fundamentally unjustifiable co-movement of share prices.

 

http://myinvestingnotes.blogspot.com/2009/11/how-to-distinguish-stock-market-bubbles.html

A Decade of Bubbles 2000-2009

"S&P 500 has fallen 23% from 1469.25 in 2000 to its current 1,126.20"

Published: Wednesday December 30, 2009 MYT 10:46:00 AM
String of investment bubbles marked 2000-09


NEW YORK (AP): A string of exploding investment bubbles that started with the dot-coms and ended with mortgages and oil dominated the years from 2000 to 2009. And it looks like the next decade will be no different.

It doesn't seem to matter to many hedge fund traders and other professional investors that the Standard & Poor's 500 index has turned in its first losing performance over the course of a decade, having fallen 23 percent from 1,469.25 at the start of 2000 to its current 1,126.20.

Or that they or other investors helped create and then destroy the bubbles that left stocks worth $2.5 trillion less today than when the decade began - and that's before adding in the effects of inflation.

A mix of investor hubris, ignorance and piles of easy money created the bubbles.

New ideas about where to invest seemed foolproof and greed crowded out doubts.

Many investors looking for the best returns failed to see the potential problems with an Internet business that had no sales plan, or that thousands of expensive homes bought with no down payment might end up in foreclosure.

Now, these investors who fled the last blowups risk running smack into others. The Federal Reserve is keeping borrowing costs low to help revive the economy, and that means there's still plenty of easy money around, helping traders to inflate the price of everything from stocks to commodities such as gold.

"They've put out the biggest punch bowl in U.S. history and people are guzzling from it," said Haag Sherman, chief investment officer at Salient Partners in Houston. It begs several questions: What will be the next bubble? Or is it already here? And, how do individual investors protect their savings?

Some analysts have already been asking if the stock market formed a bubble with its huge rebound this year. The S&P 500 is up 68.9 percent from the 12-year trading low of 666.79, its best performance since the 1930s.

Gold is also suspect. It's above $1,098 an ounce and up 24 percent in 2009. Other possible sources of bubbles include stocks in emerging markets such as China, where the Shanghai index is up 76.4 percent this year.

Analysts say it's in the DNA of markets to let ambition cloud good judgment and that even when investors learn or relearn a lesson about excess, many still forget it.

Moreover, investors still have $3.2 trillion in money market mutual funds that's waiting to be invested, according to iMoneyNet Inc. With so much cash available and investors hankering after big returns, analysts warn that bubbles may be inevitable.

The signs of effervescence can be hard to spot.

"Pets.com was going to have a market cap larger than Exxon Mobil," said David Darst, chief investment strategist for Morgan Stanley Smith Barney in New York, referring to the Web site that collapsed in November 2000, nine months after raising $82.5 million from investors.

He says investors will keep getting tripped up as they find new ways to invest. "Human nature doesn't change," Darst said. "Market mechanisms change but human fear, human greed will be like this decades and centuries hence."

The numbers from this decade tell a stunning story:

>The Nasdaq composite index, powered by the dot-com buying that began in the late 1990s, went all the way up to 5,048.62 in March 2000, then crashed down to 1,114.11 at the depths of the 2002 bear market. It rose as high as 2,859.12 in October 2007, but no one expects it to return to its loftiest levels.

And the indexes don't reflect inflation, taxes and fees, which take the value of an investment down further. Thornburg Investment Management, which analyzed the value of investments beyond the decade, said $100 invested in 1978 would have been worth only $376 thirty years later after accounting for inflation, expenses and taxes.

>Crude oil, sparked by a weaker dollar and worries that oil producers would soon be unable to meet global demand, rose 71 percent in just six months to a high of $147.27 in July 2008. Prices then crashed down to $33.87 in just five months. The plunge was so precipitous that it destroyed several hedge funds that had bet oil would just keep soaring.

>Low borrowing rates and insatiable demand for mortgage debt by investors made it easy to get loans. That helped prop up housing prices and fuel speculation on securities based on those risky mortgages. The peak came in April 2006; after that, home prices fell 31.9 percent to a low in May 2009, according to the S&P/Case-Shiller 20-city index. Along the way, two investment banks that bought mortgage-backed securities collapsed and the government spent hundreds of billions of dollars to prop up many commercial banks.

>Prices for soybeans and corn hit record levels in the summer of 2008 as floods swept the Midwest and damaged key growing regions. In the first six months of the year, corn shot up more than 60 percent and soybeans rose more than 30 percent. The jump in prices was a boon to many traders, but led to food riots in Africa, Asia and the West Indies. By December of last year, both grains had lost half their value.

Analysts say the best way to avoid being caught by other bubbles is to remain vigilant about diversifying, the practice of investing in a variety of assets. It could also mean shedding some of the stronger performers to avoid some of the risks that the winners will falter.

"When something grows too big in the portfolio you have to force yourself to scale it back a little bit," Darst said. "There's no substitute for doing your homework, there's no substitute for asking questions."

By spreading their holdings around and saving more, investors can buffer against what many analysts worry will be the fallout from the low interest rates and easy money that are being used to help revive the economy.

Policymakers also have concerns. Fed Chairman Ben Bernanke said last month a policy favoring cheap borrowing risked setting more traps for investors. He said he didn't see any signs that a bubble is emerging but also acknowledged that it is "extraordinarily difficult" to detect one forming.

Some analysts see bubbles right now. Quincy Krosby, market strategist for Prudential Financial is skeptical of gold's recent surge.

It's easy to see why gold could be in a bubble. Many investors who have bought gold are speculating that inflation will start rising because of all of the money coursing through the financial system. One of gold's greatest appeals is as a hedge against inflation.

"It will move up, but the music always stops," Krosby said of gold.

Simon Laing, a director at Newton Investment Management Ltd. in London, notes that investors are using money borrowed at low rates in the U.S. and Europe to buy stocks in other markets - raising the prospect of new bubbles.

This comes as causes of past bubbles still present obstacles.

"I don't think we've taken the medicine yet," he said. "We've had a decade of bubbles and I still think we're in the same scenario."

Krosby said individuals shouldn't be fooled into thinking that regulators have been able to curtail risk-taking in the past two years since the collapse of the market for securities based on iffy mortgages.

"They're playing in a world where professional traders dominate even though we think we've gone through this tremendous regulatory revolution," she said.

http://biz.thestar.com.my/news/story.asp?file=/2009/12/30/business/20091230104944&sec=business

BELIEVING A BULL MARKET

We are in the midst of a bull market. The market fell off the cliff in 2008. Its nadir was in March 2009. Many stocks were trading below their intrinsic value: intrinsic P/E and intrinsic P/B were much higher than the market P/E and market P/B then.

When market confidence and sentiment turned, the investors rushed in and picked up huge bargains. Many stocks were trading at huge discounts to their intrinsic values. The initial price rise from March to June 2009 was particularly fast and steep. Those who stayed invested throughout the deep recession and/or invested in the early phase of the steep rise are sitting on big gains. Since June/July 2009, many stocks are trading at fair values. Accordingly, these stocks are trading at higher prices within a narrow range.

Still many "glamour" stocks' prices continue the climb. These are the "growth" stocks. At a certain price, these stocks are fairly valued. As the prices climb, beware that the market price may be expensive compared to their fundamentally derived intrinsic values. Momentum trading and various market strategies used by 'investors' in the market tend to create bubbles. Valuation is a skill and is also subjective. Those without this skill (and this would be the majority) may not be anchored on the intrinsic value of the stock as their guide.

The present bull market is about 9 months old. Driven the poor yield from fixed income investments (FDs), the liquidity due to the low interest rates and the low market prices in March 2009, the index has risen fast. The KLSE has risen from the low of around 800 to the present of 1250. Those who rode the rise would have in general obtained an average of 40% to 50% gain since March 2009. During the last bull run in 2007, the KLSE peaked around 1350. From 1250 to 1350, this 100 point rise will translate to a gain of about 8%. It is unlikely for the market to go down to the low of March 2009. However, there hasn't been any significant correction in the present bull run. Some investors would welcome a significant correction to to consolidate the market for the next phase. A correction of 10% to 20% maybe welcomed by various players in the market.

Though the market has risen, particularly the index-linked stocks, opportunities exist for the value stock pickers still.  The year is ending on a good note, it is also a good time to rebalance one's portfolio.

----

http://myinvestingnotes.blogspot.com/2009/01/believing-bull-market.html

BELIEVING A BULL MARKET

When markets are rapidly rising, value investing invariably falls out of favor with the investing public. In an upward racing market, value stocks appear dull and stodgy as the more speculative issues rush toward new market highs. But come the correction, it all looks different. Stable value stocks seem like trusted friends.

Most bull markets have well-defined characteristics. These include:

• Price levels are historically high. 
• Price to earnings ratios are high. 
• Dividend yields are low compared with bond yields (or compared with a stock’s particular dividend yield pattern). 
• Margin buying becomes excessive as investors are driven to borrow to buy more of the high-priced stocks that look attractive to them. 
• There is a swarm of new stock offerings, especially initial public offerings (IPOs) of questionable quality. This bull market is what investment bankers and stock promoters call the “window of opportunity.” Because IPOs so often occur when Wall Street is primed to pay top dollar, seasoned investors joke that IPO stands for “it’s probably overpriced.”

Be patient: Wait for opportunities during correction or panic during a bull market

Great Opportunities to buy companies with durable competitive advantage

a) Correction or panic during a bull market:

Any company with a durable competitive advantage will eventually recover after a market correction or panic during a bull market.

b) Bubble-bursting situation:

But beware. In a bubble-bursting situation,during which stock prices trade in excess of 40 times earnings and then fall to single-digit PEs, it may take years for them to fully recover.

After the crash of 1997, it took until 2007 to match the 1990s bull market highs. There are still companies trading today at below their last decade high price. On the other hand, if you bought during the crash, as Warren Buffett often did, it didn't take you long to make a fortune.

http://myinvestingnotes.blogspot.com/2009/10/opportunities-to-buy-companies-with.html

Can investors take advantage of bubbles to make money?

Whether investors can take advantage of bubbles to make money seems to be a more difficult question to answer. Part of the reason for the failure to exploit bubbles seems to stem from greed �even investors who believe that assets are over priced want to make money of the bubble � and part of the reason is the difficulty of determining when a bubble will burst.

Over valued assets may get even more over valued and these overvaluations can stretch over years, thus imperiling the financial well being of any investor who has bet against the bubble.

There is also an institutional interest on the part of investment banks, the media and portfolio managers, all of whom feed of the bubble, to perpetuate the bubble.

Are We Headed for a Third Bubble?

Published May 12, 2009

Are We Headed for a Third Bubble?

Laughter causes mirth, not the other way around, theorized psychologist William James (brother of novelist Henry) some 125 years ago. Today, practitioners of laughter therapy feign chuckling to induce happiness. Professor Charles Schaefer of Farleigh Dickinson University in Teaneck, N.J., made a study of the matter in 2002. Students he asked to “laugh hilariously for one minute” reported sharp improvements in mood, while those who smiled were less affected and those who howled like wolves were unmoved.

Could U.S. stocks be engaged in a version of laughter therapy at the moment? Monday’s decline notwithstanding, they’ve soared in recent weeks, erasing a 25% drop suffered earlier in the year, even while good news is scarce. The economy is shrinking and its number of unemployed is swelling, if at a slower pace than in prior months. Plenty of companies have beaten earnings forecasts but few have beaten on sales, suggesting slashed costs, not growth.

A bull would say stocks often rise before economic measures improve, since traders are quicker than government statisticians. A bear would point to the several false rallies of the Great Depression, when stocks rose more than 20% only to plunge afterward to new lows. But perhaps this rally is a fake one on its way to becoming real, if not enduring, growth. After all, an unwarranted rise in share prices, if it lasts long enough, puffs up investors’ buying power and sends them to stores. Companies cash in and the economy expands.

That’s arguably what happened during the bubbly stock market of the late 1990s. A slashing of core interest rates earlier in the decade produced a brief spurt of economic growth in 1994, but it subsided the following year. Then stocks turned remarkably generous. Over five years ended 1999, S&P 500 returns ranged from 21% to 38% a year. As share prices rose, growth in consumer spending and gross domestic product accelerated. Stock gains begat growth, not the other way around.

Share prices plunged over the next three years, but consumers kept shopping as house prices jumped 35%, aided by policy makers again slashing core interest rates. Stock returns turned positive again in 2003 and a second bubble ensued, this one shared by stocks and houses. Corporate profits rose from 5.4% of gross domestic income in 2003 to 7% by 2006. Rising shares helped make companies more profitable, not the other way around.

In both cases stock prices eventually collapsed, and if this rally grows into a third bubble it will surely end badly, too. If the first two bubbles were brought on by low core interest rates, conditions for a new one are ideal. The core rate is almost zero, a record. But one difference between bubbles No. 1 and 2 suggests economic growth this time will stop well short of past peaks. During the late 1990s, Americans maintained a respectable level of personal savings. In the latest bubble, savings rates turned negative. If the first time around consumers spent stock profits and the last time they had to go well beyond profits to spend debt, a third bubble might depend on the ability of banks to finance it. With losses in commercial property loans and credit cards still likely to worsen, that seems unlikely.

The recent rally has favored economically sensitive companies—ones whose profits rise quickly as the economy grows. Investors who expect the rally to fizzle ought to swap these for shares of companies whose products sell steadily no matter what. Favor modest valuations and big, safe dividends. Both are still abundant, fortunately. Also, keep ready a generous stash of cash.


http://bx.businessweek.com/investment-banking/view?url=http%3A%2F%2Fwww.smartmoney.com%2Finvesting%2Fstocks%2Fare-we-headed-for-a-third-bubble%2F%3Fcid%3D1122